Rev Quant Finan Acc (2012) 38:131–148

DOI 10.1007/s11156-010-0222-z

ORIGINAL RESEARCH

Banks’ lending behavior and monetary policy: evidence

from Sweden

Stephanos Papadamou • Costas Siriopoulos

Published online: 7 December 2010

Ó Springer Science+Business Media, LLC 2010

Abstract The main purpose of this paper is to investigate the aggregate data about bank
loans which may hide significant information about the monetary transmission mechanism.
This study, by disaggregating bank loans data and using the relevant interest rates in
Sweden, investigates the behaviour of banks after a monetary policy tightening. By using
an unrestricted VAR model and impulse response analysis, our results show that a shock on
the policy rate affects the main components of the banks’ loan portfolios differently.
Initially, banks do not reduce lending to firms and households and they present a sluggish
reaction concerning the relevant interest rates. On the contrary, they reduce lending to
mortgage credit institutions significantly since real estate lending can be considered as a
risky long-term investment. Moreover mortgage credit institutions reduce lending for
housing purposes to non-bank public. This reduction is mainly driven by flexible rate loans
and loans secured on tenant owned apartments. Consequently, theses actions have a sig-
nificant effect on real economic activity, by amplifying the initial shock from the tight-
ening monetary policy. The latter result provides evidence of the bank lending channel in
Sweden working via mortgage lending and could be very important for policy makers.

Keywords Monetary policy and interest rates  Transmission mechanism  VAR models 
Banks

JEL Classification E40  E52  G21

1 Introduction

Recently, the traditional Keynesian transmission mechanism focused mainly on the effect
of the money market rate on investment and consequently on output, known as the ‘‘money

S. Papadamou (&)
Department of Economics, University of Thessaly, Korai 43, Post Code 38333 Volos, Greece
e-mail: stpapada@uth.gr

C. Siriopoulos
Department of Business Administration, University of Patras, Patra, Greece

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132 S. Papadamou, C. Siriopoulos

view,’’ has come under attack by a second mechanism that focuses on the significant role
of credit markets. The latter, known as the ‘‘credit view,’’ contends that two channels of
monetary transmission—the bank lending and the balance sheet channel—arise mainly due
to informational asymmetry existing between borrowers and lenders in financial markets.
According to Bernanke and Gertler (1995), the credit channel is not an independent or
parallel channel compared with the traditional one, but rather a set of factors that amplify
and propagate the conventional interest rate effect.
However, identifying empirically the monetary policy transmission mechanism in an
economy is not an easy task. According to Gertler and Gilchrist (1993a), it is surprisingly
difficult to find convincing time series evidence of the basic prediction of macroeconomic
theory that tightening of monetary policy should reduce bank lending.
The empirical properties of the monetary transmission mechanism are often charac-
terized using impulse response functions of an estimated vector autoregressive system
(VAR) that includes as variables of interest the gross domestic product in constant prices,
the consumer price index, the policy interest rate, the money supply and the total loans.
However, previous studies (see among others Buttiglione and Ferri 1994; Guender and
Moersch 1997) argued that using aggregate data for total loans may hide significant
information if the micro components of this measure follow different behavior. Following
Dale and Haldane (1995), Escriva and Haldane (1994), Garretsen and Swank (1998, 2003),
Gilchrist and Zakrajšek (1995) and Küppers (2001), we try to shed light on the empirical
relevance of the bank lending channel by introducing heterogeneity among borrowers and
not among lenders (here, banks). Theses studies have divided loans into two main cate-
gories: household loans and firm loans. This distinction ignores another important factor,
the real estate loans, that may play a significant role in the transmission of monetary policy
to economic activity. In this paper, disaggregated data about loans are used, paying par-
ticular attention to real estate loans.
Another important problem, when you use aggregate total loans in order to identify
empirically an active bank lending channel, is the necessity to distinguish between loan
supply and loan demand effects. We deal with this by using the relevant loan rates
alongside the volume of bank loans in the analysis. As far as we know, this type of analysis
is missing from the literature mainly due to the unavailability of the relevant lending rates
to several sectors. The high degree of monetary policy transparency in Sweden makes
lending rates to several sectors publicly available and can help us to investigate in a more
efficient way the existence or not of an active bank lending channel by looking at the
structure of bank loan portfolios.
Moreover, over recent years, regulatory changes, such as the sharpened focus of the
Riksbank, the Swedish central bank, on the interbank rate as an operating objective, the
strengthened market orientation of policy implementation and the abolishment of binding
reserve requirements on banks, might have amended the incentives and the ability of banks
to lend as policy changes. This leaves space for different lending responses among sectors
from banks in Sweden.
According to all the above, this paper is trying to investigate how monetary policy
affects the synthesis of banks’ loan portfolios and answer the question of whether the
lending response to a monetary policy shock is similar across different categories of
borrowers. We investigate the role that mortgage loans play in possible bank lending
channels in Sweden. Giuliodori (2005), by investigating nine European countries, men-
tioned the role of housing prices in the monetary transmission mechanism. However, he
did not provide evidence of the credit view through the importance of mortgage bank
lending.

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Banks’ lending behavior and monetary policy: evidence from Sweden 133

The rest of the paper is organised as follows. Section 2 provides the main theoretical
underpinnings concerning the credit view of the monetary transmission. Section 3 offers a
brief survey of previous research. Section 4 provides information about the data and the
main methodology of our research. In Section 5, the estimation results are presented and
compared. Finally, Section 6 concludes with some general comments.

2 Theoretical underpinnings

In contrast to the traditional or money view of monetary policy that assumes two kinds of
assets, money and bonds, in the credit view, there are three kinds of assets: money, bonds
and loans. Banks not only create money but they also issue loans. Regarding this credit
view of monetary policy, the academic literature has identified two main channels. Ber-
nanke and Blinder (1988) provide a theoretical analysis of the bank lending channel in an
extended IS-LM framework.
On the one hand, the so-called bank lending channel operates through the fall in bank
reserves brought on by a contractionary monetary policy, implying a lower supply of
loanable funds that can be used to finance investment and consumption. In particular, a
monetary squeeze raises the level of interest rates even for assets such as T-bills and
government bonds, which may be held to be risk-free. In general, banks cannot increase
deposit rates by as much since they have to build required reserves that will not offer a
below-market yield. The consequence of these events is that banks suffer a deposit drain as
investors increase their preferences towards assets with attractive yields. The deposit drain
that the banks face, together with the assumption of imperfect substitution among financial
instruments (in contrast to the money view), leads to the reduction in the loan supply by
banks with consequent effects on real activity.
The supporters of the bank lending channel claim that the impact of monetary policy on
real activity will not only depend on the level of interest rates but also on its effects on the
structure of interest rates. Due to imperfect substitutability between financial assets, an
easing of monetary policy will not necessarily produce the same effect on interest rates
across the term structure.
On the other hand, a balance sheet channel arises because rising interest rates, following
tight monetary policy, directly increase the interest expenses of the non-financial firms who
rely heavily on the debt market to finance investment decisions, reducing their net cash
flows and weakening their balance sheet positions. Further risings of interest rates are also
associated with falling asset prices, which indirectly shrink the value of the firms’ col-
lateral. These effects lead to a reduction in the firms’ net worth, thereby raising the
premium for external finance (a wedge between the cost of funds raised externally and the
opportunity cost of internal funds). This channel emphasizes the role of credit market
imperfections and of borrowers’ balance sheets in reducing incentive problems and thus
agency costs in credit markets.
As an additional contributing factor beside the bank lending channel and the balance
sheet channel, banks may not only reduce credit generally, but also adopt more stringent
lending policies for customers who are perceived to be less creditworthy, a phenomenon
known as ‘‘flight to quality.’’ Whereas the bank lending channel may be thought of as a
parallel leftward shift of the supply curve, in a supply–demand framework for loans, when
banks enact a flight to quality, however, the leftward shift will not be parallel but it will
penalize the riskier borrowers more, i.e. most likely those who were already charged higher
loan rates.

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134 S. Papadamou, C. Siriopoulos

3 Literature review

In the US, there have been several independent pieces of empirical evidence of the
importance of loan supply effects. A series of studies (see among others, Bernanke 1993;
Gertler and Gilchrist 1993b; Kashyap and Stein 1995) investigating microeconomic data
concerning the transmission mechanism of monetary policy found that the banking sector
plays an important role, a result consistent with the bank lending channel theory.
Ludvigson (1998) found that bank lending to consumers declines relative to finance
companies when monetary policy tightens, as predicted by the lending channel. Addi-
tionally, Gibson (1997) found that, when aggregate bank holdings of securities are low,
lending is more responsive to monetary policy.
Concerning studies focusing on real estate markets, McCarthy and Peach (2002) found
that an increase in interest rates leads to a decrease in property prices. Den Haan et al.
(2007) found that commercial and investment loans increase after a tightening monetary
policy shock in contrast with consumer and real estate loans, which decrease significantly.
Iacoviello and Minetti (2008), by investigating housing markets in Finland, Germany and
Norway, found a clear-cut relationship between the presence of the credit channel, the
efficiency of housing finance and the type of institutions active in mortgage provision.
Over the last years, there have been many studies providing evidence that a bank
lending channel would be more relevant in some European countries than in the US due to
the greater degree of bank dependence of non-financial firms and the concentration of
banking activity on a small number of banks. Such studies include those of Buttiglione and
Ferri (1994) for Italy, Dale and Haldane (1995) for the UK, Escriva and Haldane (1994) for
Spain and Garretsen and Swank (1998) for the Netherlands. Chrystal and Mizen (2002)
also found that credit is an important part of the transmission process of UK monetary
policy. According to Fuinhas (2008), significant sectoral differences are found among the
channels of monetary transmission in Portugal. The effects of interest rate shocks upon
economic activity are generally larger and occur more quickly when lending to corpora-
tions is considered than when lending to persons. Garretsen and Swank (2003), for the
Netherlands, find that household loans decrease instantly with an interest rate rise, in
contrast to the drop in corporate loans that presents a delay. However, the household loan
decrease is not accompanied by a significant decrease in consumer expenditure, indicating
that the bank lending channel is not very important for the transmission of monetary policy
in the Netherlands. Cecchetti (1999) argues that the importance of the credit channel
differs mainly due to the heterogeneity of financial structures among European countries.
Among studies in other countries, Ding et al. (1998), Domac and Ferri (1998) and Kim
(1999) provide evidence of an operative bank lending channel in Korea, especially before
the financial crisis at the end of 1997. Suetorsak (2006), by studying a number of East Asia
countries indicates that monetary policies impact the micro-economic decision making of
banks. Another interesting study, by Hachicha and Lee (2009), shows that the transmission
of monetary policy through the interest rate channel has become weak in the short run but
more important in the long run, in Egypt.
Furthermore, several recent empirical studies in the literature on information asym-
metries in credit markets have emphasized the importance of the balance sheet channel for
the transmission of the monetary policy (see among others De Bondt 2000; Mody and
Taylor 2004). These studies have focused on the significant role of the external finance
premium as a predictor of economic activity. De Bondt (2004) is the first to provide
evidence of an operative balance sheet channel in the European Union using aggregate
data.

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Banks’ lending behavior and monetary policy: evidence from Sweden 135

Concerning previous studies in Sweden, Hallsten (1998), using quarterly data covering
the period 1985:Q4 to 1995:Q4, finds that bank loans decline relative to commercial papers
after a monetary contraction, which she interprets as evidence of a bank lending channel
(see, e.g., Kashyap et al. 1993). Westerlund (2003), by using a panel of Swedish bank
balance sheet data covering the period 1998:M1 to 2003:M6, tests for bank loan supply
shifts by segregating banks by asset size, liquidity and capitalization. The main result is
that small, illiquid and undercapitalized banks are significantly affected by monetary
policy, which supports the hypothesis of the bank lending channel.
Finally, another important point in the relevant literature concerning bank lending
behavior is the finding of Chu et al. (2007) that banks with a low level of capitalization
have reduced their commitment with respect to lines of credit after the introduction of the
Basle Accord. Additionally, Brooks et al. (2000) argued that the impact of deregulation and
re-regulation on banking sector risk is case sensitive. Theses studies indicate that there are
not only monetary policy measures that affect bank lending behavior but also institutional
reforms.
All this research implies that the degree of bank dependence in the economy and the
extent to which central bank actions move loan supply are the key factors determining the
importance of the credit channel.

4 Data and methodology

In our study, quarterly data are used for the period 1996:Q1 to 2008:Q3. Our sample period
coincides with a single policy regime, something that is really important for the stability of
parameters in the estimation of VAR. During this period, Sweden followed a monetary
policy targeting inflation.1 Additionally, data about the lending activity of banks in Sweden
before 1996 were not available in the database Reuters Ecowin.
By assuming that the economy is described by a linear, stochastic dynamic system, a
multivariate VAR model is estimated. In such a model, we can assess the speed and degree
of adjustment of the gross domestic product due to a shock on a series of financial
variables. The VAR model captures the dynamic feedback effects in a relatively uncon-
strained fashion and is therefore a good approximation of the true data-generating process.
Since the aim of this paper is to analyze the loan portfolios of banks after a monetary
policy shock, we employ a number of VAR models with different bank loan variables: total
bank loans, household loans, non-finance corporate loans and loans to housing credit
institutions. As can be easily understood, bank loans to several categories of borrowers and
the respective lending rates are the main variables of interest.
Sims et al. (1990) argue that a VAR model in levels in the presence of cointegration is
over-parameterized and, therefore, leads to inefficient but consistent estimates of the
parameters of interest. The loss of efficiency has to be weighted against the risk of
inconsistency of estimates that occurs when the wrong cointegrating restrictions are
imposed. Imposing the wrong cointegrating parameters will make the system converge to
the long-run equilibria, but will also bias short-run dynamics, as the system is pulled in the
wrong direction. For this reason, the recent research has taken a defined line and VARs in
levels rather than cointegrated VARs are used when the issue of economic interest is
related to the short-run rather than the long-run (Favero 2001). Given that all the variables

1
In March 1993 Sweden changed to inflation targeting, but according to Sveriges Riskbank the system was
not established and operational until the end of 1995.

123
136 S. Papadamou, C. Siriopoulos

in our model are stationary in first differences2 and the fact that the VAR model involves
variables admitting stationary linear combinations,3 we estimate the VAR in levels.
Additionally, VAR in first differences provides no information on the relationship between
the levels of the variables in the VAR, and it is this aspect on which economic theory is
most informative.
Following Brissimis and Magginas (2006), we augment a standard VAR with the
composite leading indicator of near-term developments in economic activity (the Eco-
nomic Sentiment Indicator ESI a forward-looking variable) in order to control effectively
for the information set of the central bank. Based on the influential work of Sims (1980),
the basic model contains, together with the ESI, the consumer price index, the gross
domestic product in constant prices, the short-term ‘‘policy’’ interest rate proxied by the
overnight money market rate, the broad measure of money M3 and the total bank loans.
We can express the basic VAR model one as follows:
X
m
ZðtÞ ¼ C þ AðsÞZðt  mÞ þ vðtÞ ð1Þ
s¼1

where Z(t) is a column vector of the variables under consideration [ðlog ESIt Þ, ðlog GDPt Þ,
ðlog CPIÞt ðOvert Þ ðlog M3t Þ, ðlog TotLoanst Þ], C is the deterministic component com-
prised of a constant, A(s) is a matrix of coefficients, m is the lag length4 and m(t) is a vector
of random error terms.5 By construction, m(t) is uncorrelated with past Z(t)s.
Moreover in Sweden according to Basle II and EC-directives, the Act 2006:1371 on
Capital Adequacy and Large Exposures sets forth a framework for the organization of a
financing business, reporting duties and rules for monitoring and intervention. The act is
completed with more detailed provisions in the regulations and general guidelines about
capital requirements on credit risks, market risks and operational risk, issued by Finan-
sinspektionen, the Swedish Supervisory Authority. In order to take into account this sig-
nificant regulation change, a dummy variable that takes values of one since first quarter of
2007 is introduced in the VAR models.6
However, the inclusion of all the different borrowers’ variables in one and the same
model would exhaust the number of degrees of freedom too much. Hence, as a rule, we
adopt the strategy followed by Gertler and Gilchrist (1993b), and Garretsen and Swank
(2003) that estimate a series of separate VAR models including selections of variables.
These variables are the three main components of the total loans, the household loans, the
non-financial corporation loans and the loans to housing institutions.
More specifically, the second VAR includes the same variables as the basic model but
instead of total loans has the loans to households and the relevant average household loan
rates. The third VAR includes the loans to non-financial corporations and the relevant
average loan rate. Similarly, the fourth VAR includes instead of total loans the bulk of

2
The augmented Dickey–Fuller and Phillips–Perron tests have been applied. Moreover, the Elliott et al.
(1996) test and the modified Z tests of Perron and Ng (1996) have been applied because they have superior
power and size properties compared with the first two.
3
Cointegration tests based on the Johansen procedure are not presented for economy of space.
4
The optimal lag length is one under Schwarz and Hannan-Quinn information criteria.
5
Diagnostic tests (the Jarque–Bera test for normality, F-statistic versions of the Breusch–Godfrey test for
autocorrelation and the ARCH test) on residuals from estimation of Eq. 5 do not indicate any problem
concerning autocorrelation, heteroskedasticity and normality issues.
6
We would like to thank one of the anonymous referees for his helpful comment of introducing any
regulatory changes during the sample period.

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Banks’ lending behavior and monetary policy: evidence from Sweden 137

loans to housing institutions and the benchmark average lending rate of the housing
institutions to non-bank public.
Finally, it is assumed that the Central Bank of Sweden has full control over the money
market rate in that it can give an isolated, random shock to this variable, with the shock
identified by the Choleski decomposition. A major advantage of the Choleski decompo-
sition is that it does not impose theoretical priors on the model.

5 Empirical results

5.1 Banking environment in Sweden

Beginning in 1985, banks controlled the lending rate and the total amount of lending.
Riksbanken abolished all restrictions regarding lending during the fall of 1985, which led
to an expansion of credit from 1985 to 1990. This was likely the main cause of bank
failures and the Swedish bank crisis in the early 1990s. During 1991–1992, a housing
bubble in Sweden deflated, resulting in a severe credit crunch and widespread bank
insolvency. Several real estate companies went bankrupt, and the crisis in the real estate
business spread to the financial market.7
The regulatory regime change that occurred affected the actors in this market. There has
been a short period where government takes a series of measures concerning the quantity
of loans that are granted and the way that these loans are financed. Furthermore, the
structure of the actors changed. The new banking environment can be characterized by a
high degree of concentration with four large banks8 accounting for over 80% of the market.
The medium-sized group had disappeared, replaced by many new small-sized actors.
Having several kinds of credit institutions within the group makes the largest banks
dominant in the submarkets for banking and mortgage banking as well as in the segment of
other credit institutions. While foreign bank branches and saving banks, presenting lower
liquidity and assets, have a significant lower share of the market for loans (see Fig. 1a, b,
c). For saving banks, in contrast to commercial banks and foreign bank branches, net
interest income presents their main resource of income (see Fig. 1d) implying possible
different reactions to monetary policy shocks.
In Sweden, specialist credit market companies, mortgage credit institutions (known as
housing institutions), usually provide mortgage loans. There are eight mortgage institutions
in the Swedish market. Five of these are part of a banking group, while three are totally or
partly owned by the state. Lending by mortgage institutions to Swedish households
exceeds the volume of bank lending to households. The mortgage credit institutions pro-
vide credit primarily for residential property, but also for commercial and office buildings
and municipalities. Almost 72% of the mortgage institutions’ total lending consists of loans
secured on residential property.
Swedbank and Handelsbanken own the two largest mortgage credit institutions,
SwedbankHypotek and Stadshypotek, respectively. Nordea and SEB are also important
players through their mortgage credit subsidiaries (see Fig. 2). These bank-owned insti-
tutions finance their lending by raising loans from their parent banks and this makes bank
dependence significant among housing institutions. Alternatively, the credits provided by

7
It is interesting to mention at that point that the causes of the Swedish financial crisis in 1990s were similar
to those of the recent sub-prime loan crisis in USA.
8
Swedbank, Handelsbanken, Nordea and SEB.

123
138 S. Papadamou, C. Siriopoulos

(a) 9% (b) 8% Commercial

Commercial
Banks
Banks
Saving Banks Saving Banks
25% 41%
Foreign Bank Foreign Bank
Branches Branches
58%
Housing Credit 42% Housing Credit
Institutions
6% Institutions
Other Credit
2% Institutions Other Credit
6% 3% Institutions

80
(c) (d)
70
8% 3%1% Commercial 60
Banks
50
Saving
40
Banks
30
Foreign
20
Bank
Branches 10
Other Credit
88% Institutions 0
96 97 98 99 00 01 02 03 04 05 06 07 08
Commercial Banks Foreign Bank Branches
Saving Banks

Fig. 1 a Share of Average Total Assets over the period 1996–2008. Source: Sveriges Riksbank. b Share of
Average Total Lending over the period 1996–2008. Source: Sveriges Riksbank. c Share of Average Cash
and Balances with Central Bank over the period 1996–2008. Source: Sveriges Riksbank. d Net Interest
Income as % of total income for different type of banks. Source: Sveriges Riksbank

Fig. 2 Swedish mortgage

Lansforssakringar Hypotek
institutions: lending to the public,
Millions SEK, Dec. 2006. SBAB
Source: Swedish Bankers’
Association SEB Bolan

Nordea Hypotek

Swedbank Hypotek

Stadhypotek

0 100 200 300 400 500 600

mortgage credit institutions are financed by the issue of bonds and commercial papers. It
will therefore be interesting to investigate the supply of bank loans not only to households
and non-finance companies but also to mortgage credit institutions after a monetary policy
tightening. Moreover, lending behavior of mortgage credit institutions to public may reveal
significant information about monetary policy transmission mechanism.

5.2 Impulse response analysis for banks

We start our investigation into a possible bank lending channel by generating impulse
response functions due to one standard deviation innovation in the money market rate.

123
Banks’ lending behavior and monetary policy: evidence from Sweden 139

Economic Sentiment Indicator Gross Domestic Product Consumer Price Index

.04 .008 .008
.006
.02 .004
.004
.00 .000 .002
.000
-.02 -.004
-.002
-.04 -.008 -.004
5 10 15 20 25 30 5 10 15 20 25 30 5 10 15 20 25 30

Overnight Interest Rate Money M3 Total Bank Loans

.3 .03 .04

.2 .02 .02
.1 .01
.00
.0 .00

-.1 -.02
-.01

-.2 -.02 -.04

5 10 15 20 25 30 5 10 15 20 25 30 5 10 15 20 25 30

Fig. 3 Basic Model 1—Responses to a random shock in the overnight interest rate

Figure 3 presents the result for the basic model that includes as the bank balance sheet
variable the total loans. Initially, the total bank loans increase and then, after some
quarters, decrease and reach the bottom after almost two years. A tightening monetary
policy, as can be easily seen, has a significant negative effect on economic activity indi-
cators (ESI, GDP). However, consumer prices begin to drop after ten quarters, indicating a
sluggish reaction to the monetary policy shock.
Going further, we estimated models 2 and 3 to see the reaction of household and non-
finance company loans to monetary policy shocks. As we mentioned before, it is crucial to
include the relevant rates in order to conclude about a possible bank lending channel.
Firstly, lending rates for households and non-financial corporations increase significantly
but less than the overnight interest rate as a reaction to a tightening monetary policy. This
sluggish reaction is in accordance with previous literature (see Brito and Hartley 1995;
Calem and Mester 1995) that argues that rates on some sectoral loans (e.g. consumer loans)
are sticky. Moreover, the quantities of loans to these two categories initially increase,
indicating that the reaction of loans of these categories is mainly due to an increased
demand for loans from households and firms (see Figs. 4 and 5). Firms buffering a decline
in their cash flow try to respond continuously to their short-term liabilities by increasing
their loans. Another possibility is that firms borrow more to finance the increase in interest
payments as well. When interest rates begin to rise, borrowers expect additional rate
increases, and so they borrow more before interest rates increase further. It looks like banks
have significant relationships with firms and they continue their lending to them by pre-
senting a sluggish reaction to the interest rate shock. Ongena and Smith (2000) estimate
that 23% of all Swedish firms have only one bank relationship and 56% have at most two
such relationships, indicating the significant bank dependence.
Figure 6 presents the impulse responses of our variables to the interest rate shock when
we estimate model 4, which focuses on the real estate market. Mortgage lending rates from
housing institutions react similarly to the overnight interest rate in the monetary policy
tightening. Banks increase their lending rate to housing institutions and these institutions
consequently increase their lending rates for housing purposes. Loans to housing

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140 S. Papadamou, C. Siriopoulos

Economic Sentiment Indicator Gross Domestic Product Consumer Price Index

.04 .010 .008
.006
.02 .005
.004
.00 .000 .002
.000
-.02 -.005
-.002
-.04 -.010 -.004
5 10 15 20 25 30 5 10 15 20 25 30 5 10 15 20 25 30

Overnight Interest Rate Money - M3 Lending Rate to Households

.4 .04 .4
.03
.2 .2
.02
.0 .01 .0
.00
-.2 -.2
-.01
-.4 -.02 -.4
5 10 15 20 25 30 5 10 15 20 25 30 5 10 15 20 25 30

Loans to Households
.08

.04

.00

-.04

-.08
5 10 15 20 25 30

Fig. 4 Model 2 Households—Responses to a random shock in the overnight interest rate

institutions decrease significantly after almost eight quarters. By taking into account the
increase in mortgage lending rates and the decrease in bank loans to housing institutions,
we can provide empirical evidence of a significant reduction in the supply of real estate
loans. The empirical finding of Giuliodori (2005) for Sweden, that the increase in the
policy rate leads to a decrease in property prices, and the significant negative effect on
bank balance sheets of real estate crisis in the beginning of 1990s, provide us with an
argument for why banks reduce loans to housing institutions.
In order to investigate different reactions among different type of banks, models two
and three concerning lending to households and non-finance companies, are estimated
again for commercial, saving banks and foreign bank branches separately. Figure 7a shows
that there is an increase demand for household loans in all cases but the magnitudes varies
among type of banks. On the one hand, for saving banks the response is smaller implying
that they follow closely the monetary policy shock given that the net interest income is
their major source of income. On the other hand, commercial banks and foreign bank
branches given their variety of income sources follow a different pricing policy about their
loans. Additionally, foreign bank branches after the monetary policy shock they can attract
more deposits9 from their parent bank clients giving them their ability to fulfill increased
demand for loans at competitive prices, in order to gain a higher market share. This issue
might explain an increased variability (compared to the other two types of banks) in their

9
This result not presented for economy of space, is confirmed empirically by looking impulse response of
foreign non bank public deposits, to a random interest rate shock.

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Banks’ lending behavior and monetary policy: evidence from Sweden 141

Economic Sentiment Indicator Gross Domestic Product Consumer Price Index

.04 .010 .008
.006
.02 .005
.004
.00 .000 .002
.000
-.02 -.005
-.002
-.04 -.010 -.004
5 10 15 20 25 30 5 10 15 20 25 30 5 10 15 20 25 30

Lending Rate to
Overnight Interest Rate Money - M3 Non-Financial Corporations
.4 .04 .4
.03
.2 .2
.02
.0 .01 .0
.00
-.2 -.2
-.01
-.4 -.02 -.4
5 10 15 20 25 30 5 10 15 20 25 30 5 10 15 20 25 30

Loans to Non-Financial Corporations

.04

.02

.00

-.02

-.04
5 10 15 20 25 30

Fig. 5 Model 3 Non-Financial Corporations—Responses to a random shock in the overnight rate

interest margin in Fig. 1d. By looking Fig. 7b, the reaction of commercial and saving
banks are quite similar concerning supply of loans to non-financial corporation, while
foreign bank branches seems to fulfill increased demand at lower lending rates.
In accordance with Westerlund (2003) who argues that monetary policy affects banks
differently depending upon their size, liquidity and capitalization, we estimate again model
4, for two different types of groups. The one consists of the four biggest banks and the
other with the rest of the banks. The decrease in supply of loans after five quarters to
housing institutions is much larger for the second group consists of small, illiquid and
lower capitalized banks (see Fig. 7c).
Moreover, and following Basle II that distinguish between trading and investment
portfolios for banks, it will be also interested to investigate separately the impulse
responses of stock, short and long term securities holdings, to a monetary policy tightening
(see Fig. 8a, b, c). Therefore, model 1 is estimated again but instead of total loans we
included first, stock holdings and then, short term and long term securities holdings
respectively. Therefore, an interesting finding is that banks, after a monetary policy
tightening, prefer to reduce their stock holdings that refer to security portfolio that is held
for trading reasons rather than reduce the holdings on security portfolio for investment
purposes. Over recent years, banks involved significantly on stock market for trading

123
142 S. Papadamou, C. Siriopoulos

Economic Sentiment Indicator Gross Domestic Product Consumer Price Index

.02 .003
.01 .004 .002

.00 .001
.000 .000
-.01
-.001
-.02
-.004 -.002
-.03 -.003
-.04 -.008 -.004
5 10 15 20 25 30 5 10 15 20 25 30 5 10 15 20 25 30

Lending Rate
Overnight Interest Rate Money - M3 from Housing Institutions
.4 .010 .2
.3 .005
.1
.2
.000
.1 .0
-.005
.0
-.1
-.1 -.010

-.2 -.015 -.2

5 10 15 20 25 30 5 10 15 20 25 30 5 10 15 20 25 30

Loans to Housing Institutions

.08

.04

.00

-.04

-.08
5 10 15 20 25 30

Fig. 6 Model 4 Housing Institutions—Responses to a random shock in the overnight rate

(a) (b) (c)

Loans to Households Loans to Non-Financial Corporations Loans to Housing Institutions
.08 .08 .12
Saving Banks Saving Banks The four big-size banks
.06 Foreign Bank Branches .06 Foreign Bank Branches
.08
All excluding the four big-size banks
Commercial Banks Commercial Banks
.04 All Banks .04 All Banks
.04
.02 .02
.00
.00 .00
-.02 -.04
-.02
-.04 -.04 -.08
-.06 -.06 -.12
5 10 15 20 25 30 5 10 15 20 25 30 5 10 15 20 25 30

Fig. 7 Responses of lending activity by different type of banks to a random shock in the overnight rate

reasons. Given the high risk exposure weights on equities according to Basle directives,
banks prefer to reduce stock holdings more than bond holdings. Garretsen and Swank
(2003) shown that in early periods (1982–1996) where Dutch banks have not been involved
in stock market trading, and Basle directives concerning trading and investment portfolio
separation were not exist, they preferred to reduce bond holding than loans. Therefore our
results imply a significant changing behavior of banks concerning their security portfolios
given to Basle directives.

123
Banks’ lending behavior and monetary policy: evidence from Sweden 143

(a) (b) (c)

Shares Short Term Securities Long Term Securities
.3 .12
.12
.2 .08
.08
.1 .04
.04
.00 .0 .00
-.04 -.1 -.04
-.08
-.2 -.08
5 10 15 20 25 30 5 10 15 20 25 30 5 10 15 20 25 30

Fig. 8 Responses of Shares, Short & Long term securities holdings to a random shock in the overnight rate

5.3 Impulse response analysis for housing institutions

This section further examines the role of housing institutions in the monetary transmission
mechanism by investigating the response of floating and fixed rate loans granted from these
types of institutions to households and non-finance corporations. More specifically, a VAR
model that includes the same variables as the basic model is estimated, but instead of total
loans it includes the flexible rate loans to households (non-financial corporations) and the
relevant short term loan rates (3 months to 1 year) for household (non-financial corpora-
tions). Similarly, another VAR model is estimated by including loans with a fixed rate for
more than five years and the relevant interest rate for household and non-financial cor-
porations respectively. By looking on Fig. 9a, c and b, d, it is obvious that fixed rate loans
are driven from demand forces while flexible rate loans from supply forces. The significant
increase in short term rates compared to long term rates after a monetary policy tightening,
implies that households and non-financial corporations increase their demand for loans
with a fixed rate for more than five years being afraid that the initial increase in interest
rates will be continued. Consequently, housing credit institutions are willing to offer more
of these loans given their potential increase on their interest income. However, loans with
flexible rate present a different behavior. Given the significant increase in short term
lending rates loans, households and non-financial corporation reduce their demand for such
type of loans and housing credit institutions after facing a deposit drain they prefer to
reduce their supply.
By looking on Fig. 10, that presents housing credit institutions’ lending to non-bank
public broken down by collateral, it can be concluded that the reduce on Tenant-Owner
apartments is the most significant compared to offices and single-family dwellings. This
result implies that banks by reducing loans to housing institutions mainly affect housing
loans to households.10 Additionally, it seems that the ability to pay is the main force of
lending activity and not only a possible increase on real asset prices.
In the last step of our research, in order to provide evidence of an active bank lending
channel, we follow the methodology of Bayoumi and Morsink (2001), who calculate and
compare two sets of impulse responses: one with the variable of interest treated as
endogenous in the VAR and another where it is included as an exogenous variable. The
latter procedure generates a VAR identical to the former (with identical orthogonalized

10
Normally mortgage institutions only offers first mortgage, i.e. a loan pledged up to around 80 per cent of
the market value of the property. The second mortgage, i.e. a loan pledged above the first mortgage up to
around 90–100 per cent of the market value, is normally only offered by banks.

123
144 S. Papadamou, C. Siriopoulos

(a) (b)
.04 .04
Loans to Households with flexible rate Loans to NFC with flexible rate
.03 Loans to Households with fixed rate>5y .03 Loans to NFC with fixed rate>5y

.02 .02

.01 .01

.00 .00

-.01 -.01

-.02 -.02

-.03 -.03

-.04 -.04
5 10 15 20 25 30 5 10 15 20 25 30

(c) (d)
.25 .25
Lending Rates to Households maturity 3m-1y Lending Rates to NFC maturity 3m-1y
.20 Lending Rates to Households maturity >5y .20 Lending Rates to NFC maturity>5y

.15 .15

.10 .10

.05 .05

.00 .00

-.05 -.05

-.10 -.10
5 10 15 20 25 30 5 10 15 20 25 30

Fig. 9 Fixed vs Floating Loans & Rates responses to an interest rate shock. Loans granted from Housing
Institutions to households and non-financial corporations

Fig. 10 Housing credit .010

Office
institutions’ lending to non-bank
Single-family dwellings
public broken down by collateral
.005 Tenant-owner apartments
Total

.000

-.005

-.010

-.015
5 10 15 20 25 30

innovations) except that it effectively blocks off any responses within the VAR that pass
through the variable of interest.
Firstly, we estimate model 4 two times, one treating the mortgage lending rate and the
loans of banks to housing institutions, as endogenous, and one as exogenous variables.
Exogenizing these variables sharply dampens the impulse response of GDP to interest rate.
The GDP drop reaches its bottom in almost five quarters instead of eight quarters when

123
Banks’ lending behavior and monetary policy: evidence from Sweden 145

(a) (b)
.001 .001

.000 .000

-.001 -.001

-.002 -.002

-.003 -.003

-.004 -.004

-.005 -.005
5 10 15 20 25 30 5 10 15 20 25 30
Mortgage Rates & Loans from Banks Mortgage Rates & Loans from Hous.Inst. for tenant-owner
to Housing Inst. Endogenous apartment endogenous
Mortgage Rates & Loans from Banks Mortgage Rates & Loans from Hous.Inst. for tenant-owner
to Housing Inst. Exogenous apartment exogenous

Fig. 11 Responses of GDP to a random shock in the overnight rate

treating them as endogenous (see Fig. 11a). Our result suggest that, after two years about
2/3 of the direct impact of a change in the overnight call rate on GDP comes through bank
loans to housing institutions and the relevant mortgage lending rates.
Secondly, we estimate again model 4 as before but instead of loans of banks to housing
institutions, now we have loans for housing purposes granted from housing institutions to
non-bank public. By exogenizing the mortgage rates and the loans granted for housing
purposes, the impulse response of GDP to interest rate is again smaller and reaches its
bottom after five quarters (see Fig. 11b). Our result suggest that, after two years about half
of the direct impact of a change in the overnight call rate on GDP comes through housing
loans to non-bank public and the relevant lending rates.
Therefore bank loans to housing institutions, and loans granted to non-bank public for
housing purposes from housing institutions, are important transmission channels. Fig-
ure 11a, b provide empirical evidence of an active bank lending channel in Sweden
working through the real estate sector. The evidence provided in these figures is in
accordance with Bernanke and Gertler’s (1995) main view that the credit channel is not an
independent or parallel channel compared with the traditional one, but rather a set of
factors that amplify and propagate the conventional interest rate effect. However, our work
distinguish that mortgage lending is the main channel that complements the conventional
interest rate channel.

6 Conclusions

Providing empirical evidence of an active monetary policy channel using aggregate times
series data is not an easy task according to Gertler and Gilchrist (1993a). This study, by
disaggregating bank loans data and using the relevant interest rates in Sweden, investigates
the behavior of banks and housing credit institutions after a monetary policy tightening.
Credit institutions do not react in the same way concerning their lending activity across
sectors after a monetary policy tightening.
The major conclusions of this study can be presented as follows. First, after a monetary
policy tightening, the short-term increase in household and firm loans together with the

123
146 S. Papadamou, C. Siriopoulos

sluggish increase in the relevant lending rates can be explained by the increased demand
for funds. Looking at savings banks versus commercial banks and foreign bank branches
after a monetary policy shock, show a higher ability to fulfill increased demand for loans.
This is a result of parental support the foreign bank branches. Second, the increase in the
mortgage lending rate together with the decrease in bank loans to housing institutions can
be explained by the reduced supply of funds. This decrease in supply of loans is higher for
small, illiquid banks.
Another interesting finding is that banks, after a monetary policy tightening, prefer to
reduce their stock holdings. The stock holdings that are reduced refer to security portfolio
that is held for trading reasons, rather than reduce the holdings on security portfolio for
investment purposes. Garretsen and Swank (2003) by investigating Dutch banks over the
period 1982–1996, show that banks prefer to reduce bond holding more than loans to
public. Therefore our results imply a significant changing behavior of banks concerning
their security portfolios under Basle directives.
By investigating housing institutions’ lending behavior, fixed rates for more than five
year loans increase. This is while flexible rate loans decrease after a monetary policy
tightening. The former implies that the non-bank public, after the initial shock demand,
fixed rate loans for many years in order to avoid any further increase in interest rates. The
later implies that flexible rate loans are responsible for the reduction in total loans granted
from housing institutions. We look at housing credit institutions’ lending to the non-bank
public, broken down by collateral. It can be concluded that the reduction on loans secured
on tenant-owner apartments is the most significant compared to loans secured on offices
and on single family dwellings. Given the real estate crisis experienced in Sweden in the
beginning of 1990s, explains that the ability to pay is the main force of lending activity,
and not only a possible increase on real asset prices. Learning from this experience is
important in order to avoid a real estate crisis like the recent crisis in U.S. where loans were
mainly covered by expected increase on future asset prices and not the ability of borrower
to pay (Watson 2008).
In conclusion, our work distinguishes that mortgage lending and not generally credit, is
the main force that amplifies and propagates the conventional interest rate channel in
Sweden. Bank loans to housing institutions and housing loans, granted to non-bank public
from housing institutions, are important transmission channels. The housing institutions
play a crucial role in the Swedish economy concerning monetary policy transmission
channels. Based on the fact that mortgage lending is a growing industry in Europe, it is
really important for further research to investigate the role of real estate loans across
European countries. Sweden11 presents high values of mortgage debt to GDP ratio com-
pared to other European countries, but over the last years this distinction is significantly
reduced.

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